A couple of days ago, someone who currently has individual insurance could either sign up for insurance on an Obamacare exchange or pay a penalty. Now, these people can keep their current insurance and they will not have to pay a tax penalty. In other words, their outside option to the exchanges just got better.
But what about the inside option? First, the policies traded on exchanges are regulated. They have a cap on the maximum amount consumers can be charged per year. They cover pre-existing conditions etc. They are higher quality than the contracts traded outside the exchange. Second, the plans on the exchange are subsidized based on income. These two factors can imply the inside option is better than even the new outside option.
There are two countervailing effects. First, given the disfunctionality of healthcare.gov, it is impossible to calculate the inside option! Second, there could be a selection effect that makes the prices increase on the exchanges and leads to a “death spiral”. Specifically, if the people who currently have individual insurance are healthy and stay out of the exchanges, and there are a large number of them, prices could skyrocket in the exchanges. Then, paying the tax penalty makes more sense and the exchanges collapse.
Surely resolving the first countervailing effect is only a matter of time. This debacle should have been avoided but it is possible to fix. The second effect is potentially more problematic. It should be possible to estimate the size of the death spiral with enough data. Jon Gruber should be able to do it. I don’t have the data and can only offer an anecdote. On my way to the airport, my cab driver and I started discussing Obamacare. He and his two kids are on his wife’s individual insurance which costs them $1600/month and has huge deductibles. He was looking forward to getting Obamacare. He did not know about the subsidies. When I told him he got very excited. I used by smartphone to access the Kaiser Family Foundation subsidy calculator to guess what his family would have to pay for a silver plan. It was well below their current payments because they got a big subsidy. But how many people like him are there? How many people are buying plans in the individual marketplace in the first place? Someone should work this out.
Cheap Talk 
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November 16, 2013 at 8:45 am
Dan
Hi Sandeep,
You are of course correct that allowing worse plans to stick around will worsen adverse selection problems. I am not aware of any work on this particular counterfactual, but Handel, Hendel and Whinston argue that, even before allowing these worse plans, the exchanges would suffer from serious adverse selection, and the lowest class plan would be by far the most popular.
Here is the paper: http://www.econ.berkeley.edu/~bhandel/wp/Exchanges_Reclassification_HHW.pdf
They do this by using the estimates of health and risk aversion heterogeneity from Handel’s job market paper, and then simulating the policy environment of the ACA.
They also point out, probably more importantly, that you could fix this adverse selection by allowing for risk-based pricing (i.e. pricing pre-existing conditions). The cost of fixing adverse selection is dynamic reclassification risk: if you get sick, your future premiums will be higher. They argue that the welfare cost of allowing reclassification risk is likely higher than the cost of adverse selection, so that fixing adverse selection is likely a bad idea.
But for your question, I think the paper clearly implies that if there’s adverse selection now, allowing even worse plans can only exacerbate the problem.
November 17, 2013 at 9:51 pm
Sandeep Baliga
Main difference with HHW: On exchanges all plans can get a subsidy. Outside exchanges, no subsidy. Hence choice problem is different for consumers.
November 16, 2013 at 4:51 pm
Dismalist
Interesting post and interesting comment. The point of statutory health insurance is to eliminate the adverse selection problem. Some minimum must be defined, which apparently at present looks too good for people who think they are healthy. No problem: Finance the rest through general tax revenue [if only to let people think they are keeping their insurance!]. As for pre-existing conditions, the comment is perfectly correct. There must be cross-subsidization among insurance providers according to health of pool, or a contribution from general tax revenue. Friends, in a strange market like this, you gotta regulate properly. A little bit of regulation won’t work. [And I’m a free marketeer in general.]
November 27, 2013 at 6:21 pm
Mort Dubois
” First, the policies traded on exchanges are regulated. They have a cap on the maximum amount consumers can be charged per year. They cover pre-existing conditions etc. ”
The policies bought on and off exchange all have the same requirements. Any conclusions based on this statement are incorrect.